Optimize the Benefits of LRP and LGM:

Hog producers who are evaluating forward price or margin coverage have many different risk management tools to help address their varied market exposures. In addition to physical and exchange traded instruments, Livestock Risk Protection (LRP) and Livestock Gross Margin (LGM) can provide valuable protection for certain price risks. It is important for producers to understand the features and merits of these two programs so they can decide which product (or which combination of products) is a good fit for their specific operation. Both programs can offer potential advantages, but they are different and thus producers need to carefully consider direct comparison between the two.

LRP is designed to protect hog price, specifically the CME Lean Hog Index value, while LGM is a margin-based program that offers protection based on a standardized crush formula incorporating corn, soybean meal, and lean hog futures prices. Relatively recent improvements to both LRP and LGM have increased their risk management value and made them more attractive to producers. As a result, participation has risen significantly for both programs over the past several crop marketing years.

Figure 1.  Increased Industry Usage

For LGM, in July 2020 subsidies were applied to the insurance premium and the premium due date was moved to the end of the coverage period. Starting in July 2021, LGM was offered weekly versus the previous monthly offering. 

While not directly comparable, historical studies have been done to determine whether LRP or LGM has offered a better return for a given premium cost and deductible. Given most producers using LGM will elect the $10 deductible, and that there is also a 6-month horizon on coverage with this program, we can compare the historical performance of using LRP versus LGM under these constraints. Figure 2 shows that while returns have been higher for LGM as the deductible increases to the $10 level, the advantage shifts to LRP with a lower deductible for more at-the-money coverage (the typical LRP use case).  

Figure 2.  LRP vs. LGM Deductible Analysis

While the above comparison is a historical fact, further analysis is vital to understand the differences and maximize the opportunity presented by both programs. There are several important limitations to these types of direct comparisons. First, it is important to note that a direct comparison is only possible on the days LGM was offered (monthly or weekly versus daily for LRP). Next, the timing of improvements to LGM (which raised both the attraction of using LGM and the opportunities for its use) coincided with years in which we have witnessed a sharp increase in both corn and soybean meal prices. Also, because LRP only protects the hog price, this analysis does not take into consideration any independent feed coverage a hog producer using LRP may have – either through raising their own crops or protecting against increased cost through other channels. Last, because LGM is only offered 6 months into the future, the comparison ignores the fact that utilizing LRP further out in time potentially increases its benefits. Below are some points that informed producers should weigh when comparing and using these two valuable products.

Features of LGM:

Based on publicly available data, most producers who use LGM have chosen an approximately $10 per head deductible and will typically add coverage in at least 2 months to optimize the premium subsidy. By increasing the deductible, producers can reduce the insurance premium by a significant percentage of the change in deductible. Another attribute of LGM is that it has no annual head limit (whereas LRP has a 750,000/year head limit) which can be attractive for some larger producers. LGM may also be a good fit for shorter term coverage because the nearest available LRP expiration is 13 weeks out in time. LGM is also potentially applicable in situations where producers are less active risk managers or for addressing tail risk in conjunction with other risk management strategies.

Features of LRP:

LRP is available 52 weeks in advance, providing producers an additional 6 months to implement risk management strategies if presented with an attractive opportunity. Because LRP is based solely on hog prices, a producer can immediately supplement LRP coverage with certain exchange traded instruments if it fits their bias and risk tolerance. For many producers, the CME Lean Hog Index (which LRP settles against) more closely tracks their specific packer contracts and can therefore reduce basis risk. Also, because LRP is offered most days, producers can select coverage end dates that address periods during the year which have notoriously weak basis (late December and early January for example). Lastly, producers that also grow some or all of their corn needs might not have the feed exposure addressed by LGM.

Fortunately, starting last summer, producers can use both LGM and LRP together if the endorsements don’t end in the same month. This change should lead producers to increasingly incorporate both programs into their risk management plans. There are pros and cons to each program, and understanding these benefits and limitations should help guide their uses. An informed producer can choose the combination of risk management tools that best fits their operation and adds value by maximizing the unique advantages of each program.

Please contact us to learn more about how to optimize the use of these valuable insurance tools as part of a comprehensive risk management strategy for your hog operation.